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New Treaty Shopping Rules — Should Canada “Wait and See”?

Foreign-based multinationals and foreign corporations investing in or through Canada will want to closely follow developments now that the Department of Finance has ended its formal consultations on possible measures to combat “treaty shopping” abuses and the related erosion of Canada’s tax base.

KPMG Canada welcomed the opportunity to contribute to the public debate on this important matter during these consultations. Overall, KPMG suggests that it may not be necessary to introduce new measures to combat treaty shopping at this time and that unilateral measures could even be detrimental for Canadian multinational businesses and Canada’s relationship with its trading partners.

As signaled in the March 2013 federal budget, the Department of Finance released a 25-page discussion paper titled “Consultation Paper on Treaty Shopping — The Problem and Possible Solutions” on August 12, 2013. Finance asked interested parties to provide input during a four-month consultation period ending December 13, 2013 before it decides on a course of action.

What is treaty shopping?

Finance’s consultation paper describes treaty shopping as an abuse that arises when a non-resident of Canada (who is not entitled to the benefits of a tax treaty with Canada) seeks to obtain the benefits of one of Canada’s bilateral treaties by indirectly using an entity resident in another country with which Canada does have a treaty to earn income through Canada. The paper says that these treaty shopping techniques provide “indirect and unintended tax benefits to residents of third countries.”

The paper generally defines treaty shopping, describes its detrimental effects on Canada and proposes possible solutions. The paper solicits comments to help develop an effective anti-treaty-shopping rule to protect the integrity of Canada’s bilateral tax treaties. For more on the consultation paper, see KPMG’s TaxNewsFlash-Canada 2013-31, “Canada Moves to Curtail Treaty Shopping”.

KPMG recommends a “wait and see” approach

KPMG suggests that a “wait-and-see” approach may be the most prudent course of action for Canada. For example, Canada could consider delaying any substantial action on treaty shopping until the Organisation for Economic Co-operation and Development (OECD) has released its findings on base erosion and profit shifting (BEPS) (see KPMG’s TaxNewsFlash-Canada 2013-27, “OECD Action Plan Could Signal a Shift in the Global Tax Landscape”).

Canada may also want to wait to see other countries’ experiences with anti-treaty shopping provisions over the longer term before taking any action because no clear consensus has yet arisen out of the international experience. It seems that most countries are struggling to find an appropriate balance between protecting their tax base and maintaining access to the global market. Given the absence of a clear answer, the “wait and see” approach may allow Canada to observe other countries’ experiences and formulate a more measured response.

KPMG’s recommendations

KPMG’s submission on Finance’s consultation paper focuses on the following key recommendations:

Define purpose for entering into tax treaties

Canada does not appear to have made a clear, coherent tax policy statement to determine the countries with which it enters into treaties (i.e., they are not necessarily high tax countries). In contrast, entering into Tax Information Exchange Agreements appears to have clear policy objectives. This situation would seem to support the view that economic investment may be a primary driver in negotiating tax treaties. Further, it appears that from a policy perspective, Canada seeks to negotiate similar provisions in its treaties regardless of the country with which it is negotiating. If this is correct, then it should not be a significant concern from a tax policy perspective if the benefit of one treaty is used over another.

KPMG appreciates that certain of Canada’s policy choices will have evolved over time and therefore some of Canada’s older treaties may not reflect Canada’s current tax policy choices. However, it is expected that Canada will renegotiate these treaties over time to reflect current policy objectives. On this basis, it is not clear that treaty shopping ought to be a major tax policy concern (in terms of the use of one treaty over another).

Further, KPMG notes that where Canada has deviated from its preferred treaty policy, a comprehensive limitations-on-benefit provision was included in the treaty (i.e., the 2007 Protocol to the Canada-U.S. Tax Convention). Without a clear understanding of the policy that informs Canada’s decisions to negotiate tax treaties, it is not clear what perceived abuses treaty shopping measures are intended to combat, which makes it difficult to formulate an effective solution.

Avoid unilateral override to bilateral relationships

Tax treaties are the result of bilateral negotiation and agreement with foreign jurisdictions. As such, Canada has a responsibility to uphold the mutually agreed upon benefits in its bilateral treaties as stated in those treaties. The unilateral creation of a domestic rule that overrides the provisions of treaties in certain circumstances may be viewed as contrary to the spirit in which those treaties were negotiated.

Monitor results from OECD and its BEPS Action Plan

Canada should consider delaying any substantial action on treaty shopping until the OECD has released its findings on the Action Plan on base erosion and profit shifting (BEPS Action Plan). For more on the BEPS Action Plan, see KPMG’s TaxNewsFlash-Canada 2013-27, “OECD Action Plan Could Signal a Shift in the Global Tax Landscape”.

Although it does not explicitly address treaty shopping, delaying substantial action is consistent with the approach recommended by Canada’s Standing Committee on Finance in its recently issued report on “Tax Evasion and the Use of Tax Havens”. This report encourages the federal government “to continue to support the efforts of the Group of Twenty finance ministers and central bank governors to develop measures to address base erosion and profit shifting, to take necessary collective actions and to examine the Organisation for Economic Co-operation and Development’s forthcoming comprehensive action plan.”

Wait to see international experiences before taking action

A survey of KPMG’s international member firms indicated that there was no perfect model or singular tool available to combat treaty shopping. This lack of consensus may be a further indication that it would be inadvisable to draft a unilateral domestic rule and that Canada should wait to see other countries’ experiences and reactions to the work of the OECD on BEPS before implementing a course of action that may not be effective.

KPMG Canada’s survey included discussions with senior international tax professionals in KPMG offices in the top countries with foreign direct investment into Canada. These countries included the United States, Netherlands, United Kingdom, Switzerland, Brazil, Japan, Luxembourg, Germany, China, Australia and France.

Alternatively, if Canada wishes to take immediate action (contrary to KPMG’s main recommendation that Canada consider a more prudent collective approach consistent with the advice of the OECD and the Standing Committee on Finance), KPMG recommends that Canada take a two-pronged approach that includes:

The renegotiation (or termination) of treaties, as desired and/or necessary, and

The use of the current general anti-avoidance rule (GAAR) provisions.

KPMG believes that if treaty shopping is a concern, the number of treaties that Canada would seek to renegotiate (or terminate) is probably relatively limited. If so, renegotiation (or termination) of these specific treaties may be a more preferable and targeted approach, rather than introducing a separate domestic rule with a broad brush that may create uncertainty in the tax system and that might ultimately inhibit foreign investment in Canada.

With this approach, the GAAR could still be used to address perceived treaty shopping abuses. In KPMG’s view, it is in the government’s best interest to allow the GAAR to function as it was intended, until such time as it has proven itself ineffective in this regard.

Provide examples of treaty shopping

If Canada pursues this two-pronged approach, it would be very helpful if the government would issue a clear statement of its anti-treaty shopping policy and provide specific examples of treaty shopping. This clear policy would provide taxpayers with some predictability and certainty as to when the GAAR should apply to investment in Canada through another country.

It seems clear that Finance perceives treaty shopping to be a significant problem that erodes Canada’s tax base. While measures to curb treaty shopping will almost certainly be tightened, their precise form remains unclear. The government’s final proposal could appear sometime in 2014, perhaps as early as the 2014 federal budget.

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We can help

Your KPMG adviser can help you assess the potential impact of an upcoming anti-treaty shopping rule on your corporate structure and your international tax planning, and to prepare for forthcoming changes to the international tax landscape. For more details on these developments and their potential impact, contact your KPMG adviser or Jodi Kelleher, Leader of KPMG in Canada’s International Corporate Tax practice, at jkelleher@kpmg.ca.

Information is current to December 17, 2013. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.

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